Edited version of your written advice

Authorisation Number: 1012724589486

Ruling

Subject: Non-commercial losses

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your activity in the calculation of your taxable income for the 2013-14 financial year?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You meet the income requirement of Division 35 of the ITAA 1997

During the 2013-14 financial year you purchased two separate franchises.

These franchises were in pre-launch in the relevant financial year however you were only in a position to generate income after dd/mm/yyyy due to the franchise agreement terms.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 35-10(1)

Income Tax Assessment Act 1997 subsection 35-10(2)

Income Tax Assessment Act 1997 subsection 35-10(2E)

Income Tax Assessment Act 1997 paragraph 35-55(1)(b)

Reasons for decision

For the 2009-10 and later income years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless:

• you satisfy the income requirement and you pass one of the four tests,

• the exceptions apply, or

• the Commissioner exercises his discretion.

In your situation, none of the exceptions would apply and although you satisfy the income requirement, you do not meet any of the four tests in the years of income under consideration. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion.

The relevant discretion may be exercised for the income year in question where:

• it is in the nature of the business activity that there will be a period of time before it can be expected to pass one of the four tests

• there is an objective expectation your business activity will produce a tax profit or meet one of the four tests within a commercially viable period for your industry.

In order for Division 35 of the ITAA 1997 to apply, a taxpayer must have commenced business. In determining when a business commences, there are three indicators that must be present. These are:

• purpose, intention and decision;

• acquisition of a business structure; and

• commencement of business operations

We must examine the above indicators in light of the characterisation of your activity. In Goodman Fielder Wattie Ltd v. Federal Commissioner of Taxation 29 FCR 376; (1991) 22 ATR 26; 91 ATC 4438, Hill J stated:

Critical to the resolution of the present controversy, is the characterisation of the business activity itself which is said to have commenced. It was conceded properly by the applicant that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling monoclonal antibody products, then that business did not commence until around November 1982...

The information which you have provided clearly indicates that your intended business activity is best characterised as a trading activity. Your intention is to receive a fee from customers who wish to use your services.

Purpose, intention and decision:

The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business. However, not all businesses commence in such an orderly manner.

The information you have provided shows that your research concluded that a viable business is available.

Acquisition of a business structure:

Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

In Calkin v. CIR [1984] 1 NZLR 440 Richardson J said at 446-447:

'Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations.'

For a business activity to commence, an appropriate business structure should be in place. As to what this structure will consist of, and its size, this will be a question of fact and degree, and depend on the nature of the business activity.

Your business activity is contracting businesses to join a program. You planned the requirements you will need for this activity.

Commencement of Business Operations:

As noted by Brennan J in Inglis v. Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on. Brennan J stated at ATC 4004-4005; ATR 496-497 that:

'The carrying on of a business is not a matter merely of intention. It is a matter of activity. Yet the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the supposed business is being conducted'.

It is accepted that, during the 20XX financial year you had gone beyond merely having an intention to engage in business by undertaking the necessary franchise purchase.

However, you were not able to commence trading in the relevant financial year as this was delayed until the subsequent financial year.

We consider that, up to this point, your activities were preliminary to the carrying on of your intended business and you were still in the course of establishing a business.

The costs associated with the establishment of a trading entity are capital in nature as they relate to the structure of the business rather than the daily activities from which the business gains its assessable income (see Federal Commissioner of Taxation v. Maddalena 71 ATC 4161; (1971) 2 ATR 541.

The non-commercial business loss rules only apply if you are carrying on a business. As it is considered that your business activity had not commenced in the relevant financial year Division 35 of the ITAA 1997 does not apply.